Chapter 11 Confirmation

The proponent of a plan of reorganization solicits acceptance of its plan from creditors with a bankruptcy court approved disclosure statement.

Requirements for Court Approval

Before soliciting votes on a plan, the proposed disclosure statement must be approved by the bankruptcy court as containing “adequate information.”

Section 1125(a) of the Bankruptcy Code defines “adequate information” as “information of a kind, and in sufficient detail, as far as is reasonably practicable in light of the nature and the history of the debtor and the condition of the debtor’s books and records, that would enable a hypothetical reasonable investor typical of holders of claims or interests of the relevant class to make an informed judgment about the plan.”

Although courts differ regarding individual items which must be included, at a minimum, a disclosure statement should contain:

A description of the debtor’s business;

A synopsis of the debtor’s pre-bankruptcy history;

Information regarding the debtor’s operations;

A description of the plan and how it is to be executed;

A liquidation analysis;

A listing of management to be retained and such management’s compensation;

Cash flow projections of operations;

A discussion of pending litigation and transactions with insiders; and

An analysis of the tax consequences of the plan.

The determination of whether a disclosure statement contains adequate information is within the bankruptcy court’s discretion.

When soliciting acceptances of the plan, a copy of the proposed plan is included with the court-approved disclosure statement.

For a “small business debtor” (which is defined by the Bankruptcy Code as a person engaged in business whose debts do not exceed $2 million), the court may “conditionally” approve a disclosure statement for solicitation to creditors, and may reserve final approval of the disclosure statement for a combined hearing on plan confirmation.

The Exclusivity Period

“Exclusivity” refers to the debtor’s initial right to propose, and then solicit votes in favor of, a plan of reorganization.

During the first 120 days of a Chapter 11 case, the debtor has the exclusive right to file a plan of reorganization, and (if a plan is filed within that time) an additional 60 days to solicit acceptances of its plan.

Upon notice and hearing, this period may be extended or shortened by the bankruptcy court for cause.

The appointment of a trustee in a Chapter 11 case terminates the exclusivity period

If the debtor is a “small business,” the exclusivity period is shortened from 120 to 100 days, and may only be extended if the debtor meets a higher standard (by showing that the need for the extension is due to circumstances beyond its control).

Once the exclusivity period is terminated, any party in interest may propose a plan of reorganization. For example, a creditor may file a plan proposing to eliminate equity holders’ interests, provide for the sale of the debtor’s assets, or provide for the transfer of all of the debtor’s property to its creditors in satisfaction of debt.

Confirmation Standards Under Bankruptcy Code Section 1129

Section 1129(a) lists thirteen separate findings which a bankruptcy court must make in order to confirm a plan of reorganization.

Of these, some of the more typically contested criteria are:

The plan must comply with the applicable provisions of the Bankruptcy Code (among other things, this incorporates the Bankruptcy Code’s requirements regarding claims classification);

The proponent of the plan must have complied with applicable provisions of the Bankruptcy Code (for example, the plan proponent may not improperly have solicited acceptances of the plan);

The plan must have been proposed in good faith and not by any means forbidden by law; vThe plan must contain required disclosures regarding the identity of management and insiders to be employed by the reorganized debtor;

Each impaired class must have either accepted the plan, or must receive or retain under the plan as much as it would receive in a Chapter 7 liquidation proceeding (this requirement is often referred to as the “best interests” test);

If a class of claims is impaired, at least one impaired class (excluding insiders, as defined in section 101(31) of the Bankruptcy Code) must have accepted the plan; and

Confirmation of the plan is not likely to be followed by liquidation or the need for further financial reorganization of the debtor (this requirement is often referred to as the “feasibility” test).

Even absent objection, the bankruptcy court has an independent obligation to determine whether all of the requirements of section 1129(a) have been met.

The plan’s proponent bears the burden of proof as to each of these statutory requirements.

Many standards for confirmation of a plan concern “impaired” classes of parties in interest.

Under section 1124 of the Bankruptcy Code, a class of claims or interests is impaired unless:

The plan leaves unaltered the legal, equitable, and contractual rights to which such claim or interest entitles the holder of such claim or interest; or

Notwithstanding any contractual provision or applicable law that entitles the holder of such claim or interest to demand or receive accelerated payment of such claim or interest after the occurrence of a default, the plan:

Cures any such default that occurred before or after the commencement of the bankruptcy;

Reinstates the maturity of such claim or interest as such maturity existed before such default;

Compensates the holder of such claim or interest for any damages incurred as a result of any reasonable reliance by such holder on such contractual provision or such applicable law; and

Does not otherwise alter the legal, equitable, or contractual rights to which such claim or interest entitles the holder of such claim or interest.

For example, a class of unsecured creditors proposed to be paid in full, but without interest and over time, is impaired because its legal rights are not unaltered.

Acceptance of a plan is governed by section 1126 of the Bankruptcy Code.

Only holders of claims or interests allowed under section 502 of the Bankruptcy Code may vote to accept or reject the plan.

For a class to accept a plan:

More than one-half in number of holders of allowed claims in such class must vote in favor of the plan; and

Holders of at least two-thirds in amount of allowed claims in such class must vote in favor of the plan

Thus, a creditor or group of creditors having allowed claims accounting for at least one-third of the total debt in a class may (absent “cram-down,” discussed below) exercise “veto power” over a plan./li>

To satisfy the “best interests” test, the creditor must receive more then it would in a Chapter 7 liquidation proceeding.

If this issue is disputed, evidence must be offered on, among other things, the present value of any deferred payments under the plan, the liquidation value of the debtor’s assets, and the effect of expenses of administering a Chapter 7 liquidation.

To satisfy the “feasibility” requirement, the plan proponent must establish that the plan has a reasonable assurance of success.

Bankruptcy courts consider a multitude of factors for assessing the chances of a plan’s success, such as:

The capital structure of the reorganized debtor (for example, whether the reorganized debtor is overleveraged);

The reorganized debtor’s financial projections; and

The qualifications of the reorganized debtor’s proposed management team and business plan.

“Cramdown” and the Absolute Priority Rule

Even if all of the impaired classes do not accept a plan, the plan may nevertheless be confirmed under the section 1129(b) – the “cramdown” provision of the Bankruptcy Code.

Under the cramdown standard, the bankruptcy court may confirm the plan over the objection of a dissenting impaired class if the plan does not “discriminate unfairly” against, and is “fair and equitable” with respect to, each class that is impaired under, but has not accepted, the plan.

In addition, other than the requirements contained in section 1129(a)(8), the plan must still meet all of section 1129(a)’s remaining tests. Thus, at least one non-insider, impaired class must accept the plan as a precondition to cramming-down the remaining non-accepting classes.

The Bankruptcy Code does not define “unfair discrimination.”

The first of three approaches to determining the issue of unfair discrimination adopted by bankruptcy courts is a mechanical approach, under which all unsecured creditors must be paid the same percentages of their claims, even if claims are properly placed in more than one class.

A second approach used by courts determines whether discrimination is fair with reference to whether a subordination agreement exists.

The third approach adopts a four-part test, in which the bankruptcy court:

Determines whether the discrimination is supported by a reasonable basis;

Determines whether a plan may be confirmed and consummated without discrimination;

Determines whether the discrimination is proposed in good faith; and

Considers the treatment of the classes discriminated against.

The determination of whether the treatment proposed to holders of claims in an impaired, non-accepting class is “fair and equitable” is governed by section 1129(b)(2) of the Bankruptcy Code.

Treatment of secured creditors is fair and equitable if:

The plan provides:

That the holders of such claims retain the liens securing such claims, whether the property subject to such liens is retained by the debtor or transferred to another entity, to the extent of the allowed amount of such claims; and that each holder of a claim of such class receive on account of such claim deferred cash payments totaling at least the allowed amount of such claim, of a value, as of the effective date of the plan, of at least the value of such holder’s interest in the estate’s interest in such property;

For the sale, subject to section 363(k) of the Bankruptcy Code, of any property that is subject to the liens securing such claims, free and clear of such liens, with such liens to attach to the proceeds of such sale, and the treatment of such liens on proceeds under clause (i) above or clause below; or

For the realization by such holders of the indubitable equivalent of such claims.

Thus, under the first prong of this test, in addition to retaining its lien on its collateral to the extent of the allowed amount of such claim (i.e., the secured component of the debt), a secured creditor must receive deferred cash payments totaling the allowed amount of its claim and having a value, as of the effective date of the plan, at least equal to the value of the collateral securing its claim.

Therefore, if a secured creditor is owed two dollars, but its collateral is only valued at one dollar, and the creditor has made a section 1111

election to have its claim treated as a single secured claim (in contrast to bifurcating the claim into a one dollar secured claim and a one dollar unsecured claim), the plan must pay the secured creditor a stream of cash payments of not less than two dollars, which stream of payments must have a present day value of at least one dollar.

In contrast, if the secured creditor does not make the section 1111(b) election, and therefore opts to bifurcate the claim into separate secured and unsecured claims of one dollar each, then it must be paid a total of one dollar on behalf of its secured claim, on a basis such that the stream of payments have a present day value of at least one dollar. c) The proposed interest rate plays a key role in this analysis.

Traditionally, there have been four competing approaches – the formula rate, the coerced loan rate, the presumptive contract rate, and the cost of funds rate – to determining the correct and appropriate interest rate. Although there have been numerous conflicting decisions as to the appropriate rate, the Supreme Court recently ruled that that the so-called formula approach (the prime rate plus a calculated risk factor) best meets the intent of Congress and the objectives of the Bankruptcy Code.

The formula rate incorporates a “national prime rate” with an evidentiary hearing where the parties may present evidence about the “appropriate risk adjustment.” Because the approach is already familiar in the financial community, it minimizes the need for expensive evidentiary proceedings. one dollar.

In selecting the formula rate, the Supreme Court also recognized that the cram down provision requires an objective rather than a subjective standard.one dollar.

The bankruptcy court’s finding that the debtor’s plan proposed appropriate interest rate does not, in and of itself, mean the court will find the plan to be “fair and equitable.”

Although section 1129 does not prohibit long term payouts, the proposed payment term must be a reasonable period.

Treatment of unsecured creditors is “fair and equitable” if:

The plan provides that each holder of a claim of such class receive or retain an account of such claim property of a value, as of the effective date of the plan, equal to the allowed amount of such claim; or

The holder of any claim or interest that is junior to the claims of such class will not receive or retain under the plan on account of such junior claim or interest any property.

Thus, to satisfy this test, an unsecured creditor must receive payment of the full amount of its claim, or no junior creditor or holder of equity interests may receive or retain any property under the plan.

This second requirement is known as the “absolute priority rule.”

To satisfy the absolute priority rule, junior claims and interests may not receive any payment or retain any value under a plan of reorganization unless all senior claims either consent or have been paid in full.

Thus, equity holders may not retain their interests unless all creditors have been entirely paid.

Courts have concluded that an exception to the absolute priority rule exists. Under this “new value exception,” holders of the debtor’s equity interests may receive property (such as stock in the reorganized debtor) under a plan where the distribution is made in consideration of a new, post-bankruptcy contribution of money (or money’s worth) reasonably equivalent to the value of the property received.

This distribution must be on account of the new value contributed, and may not be on account of old interests.

Practical Considerations of Confirming a Plan, Including Votes

Contents of the Plan

Section 1123(a) of the Bankruptcy Code lists the things a plan must do (in addition to satisfying the confirmation standards of section 1129).

Among other things, a plan must:

Designate classes of claims and classes of interest;

Specify any class of claim or interest that is not impaired under the plan;

Specify the treatment of any class of claim or interest that is impaired under the plan;

Provide for the same treatment of claims or interests of a particular class, unless a holder agrees to a less favorable treatment; and

Provide adequate means for implementation of the plan (such as retention by the debtor of all or part of the property of the estate, transfer of all or part of the estate to one or more entities, merger or consolidation of the debtor with one or more persons, sale of all or part of the property of the estate, satisfaction or modification of any lien, cancellation or modification of any indenture, curing or waiving of any default, extension of a maturity date or change in an interest rate, amendment of the debtor’s charter, or issuance of securities of the debtor for cash, for property, for existing securities, or in exchange for claims or interests).

Of these requirements, the proposed classification of claims may be the most controversial requirement, as a claim’s classification dictates the treatment of such claim. Placement in a particular class may determine the amount and timing of payment, and the ability to control that class’s acceptance or rejection of the plan.

As previously discussed, section 1129(a)(10) of the Bankruptcy Code requires that at least one non-insider, impaired class must accept the plan and a class acceptance must be by more than half of the creditors in the class who hold claims equal to at least two-thirds of the total claims in the class. As a “deficiency” claimant (that is, a secured claimant holding a claim which has been bifurcated into secured and unsecured portions) holding more than one-third of the unsecured debt could veto acceptance, debtors frequently attempt to separately classify a deficiency claimant from other unsecured creditors.

The ability to include or exclude creditors from a class is governed by section 1122 of the Bankruptcy Code.

Section 1122(a) provides that, except for a class of claims created for administrative convenience under section 1122(b), a plan may place a claim or an interest in a particular class only if such claim or interest is substantially similar to the other claims or interests of such class.

Some courts have stated that this section does not prohibit separate classification of similar claims, but rather merely proscribes the placement of dissimilar claims in the same class.

Courts have taken various approaches to adjudicating the propriety of classification.

Some courts have construed section 1122 strictly, concluding that separate classification of unsecured claims violates section 1122(a), and that Congress intended all unsecured claims be grouped in one class.

Other courts have adopted a more flexible approach to claim classification, concluding that statute’s “substantially similar” language does not require that all similar claims be placed in one class. Instead, these courts simply require that any class so created be homogenous. These courts accept separate classification of similar claims as long as the separate classification is based on legal or factual distinctions, and is not for the purposes of “gerrymandering” the voting process.

Courts disagree as to whether an undersecured creditor’s deficiency claim is legally distinct from other unsecured claims.

Even if a bankruptcy court permits separate classification, the plan proponent may nevertheless have to overcome the unfair discrimination and absolute priority rule issues hurdles with respect to such creditors.

In addition to the “must do” requirements of section 1123(a) of the Bankruptcy Code, section 1123(b) of the Bankruptcy Code provides that a plan may:

Impair or leave unimpaired any class of claims or interests;

Provide for the assumption, rejection, or assignment of any executory contract or unexpired lease of the debtor;

Provide for the settlement or adjustment of any claim or the retention and enforcement by the debtor, the trustee, or a representative of the estate appointed for such a purpose, of any such claim or interest;

Provide for the sale of all or substantially all of the property of the estate, and the distribution of the proceeds of such sale among holders of claims or interests;

Modify the rights of holders of secured and unsecured claims; and

Include any other appropriate provisions not inconsistent with the Bankruptcy Code.

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